Guarantees: “The best laid plans of mice and men oft go awry…”

Welcome to HMA Bites! In each edition of Check-In we will take a concise look at an issue relating to hotel management agreements ("HMAs") and provide insight, tips and advice based on our experience in practice. In this edition, we will look at the topic of guarantees – something you never need until you need it, and if you don’t have it, you may really wish you did.

It’s easy to think that a HMA is a bi-partite relationship – one between Owner and Operator. But as part of entering into any HMA, one should consider whether it’s worth bringing in a third wheel…

What is a guarantee? In its simplest form, a guarantee is an obligation on a party (the “Guarantor”) to perform an obligation that another party (the “Primary Obligor”) has failed to perform. This means that if the Primary Obligor defaults in its performance of the relevant obligation, then the party to whom the obligation is owed (the “Beneficiary”) can demand the Guarantor perform the obligation. If the Guarantor also fails to perform the obligation, then both the Primary Obligor and Guarantor will be liable to the Beneficiary.

Why are guarantees sought? To answer this, it’s worth having a quick refresh of some established principles of English law, being the corporate veil and privity of contract. Save for some limited exceptions (such as tortious liability and fraud), a party’s liability for its actions under a contract is limited to the bounds of that party’s legal personhood. 

This means that if a party defaults under a contract, then the non-defaulting party can only make a claim against that defaulting party, and if that claim is successful, it can only be enforced against the defaulting party and the assets owned by it. In other words, liability is “ring-fenced” within the defaulting party (and can’t touch its shareholders, directors or employees, for example, even if they were directly responsible for the default).

The practical consequence of this is that, if you contract with a party that lacks sufficient substance and that party defaults, then your ability to enforce your legal rights (and recover your losses) may be worth little more than the paper they’re written on.

Guarantees are used in many different types of legal arrangements, and so how are they relevant to HMAs? 

From a general standpoint, both an Owner and Operator would be prudent to seek a guarantee where the other party lacks adequate financial or operational substance, for example if it is a newly incorporated or shell company.

Specific scenarios where a guarantee would be common include the following:

  • If the Owner doesn’t hold the main property interest in the Hotel (e.g. where it holds a lease from a parent company, as in a PropCo – OpCo structure) 

  • If there are any fixed financial commitments, e.g. an Operator obligation to achieve certain revenue or profit thresholds, or an Owner obligation to pay (or re-pay) key money 

  • If a party has certain payment obligations in relation to its liability, e.g. indemnities or liquidated damages

There are various forms a guarantee can take, which will depend on the individual circumstances and negotiations. A guarantee could be limited to guaranteeing specific obligations only, financial obligations only, or all of the Primary Obligor’s obligations (which could be extended to operational obligations relating to the management of the hotel). A guarantee could be given by a corporate entity or individual, or multiple entities or individuals (on a joint and several basis). 

A party required to give a guarantee will likely try to negotiate a cap on or exclusions from its liability under the guarantee, or to limit the guarantee in time.

It’s important to note that the law on guarantee can vary significantly between different jurisdictions, and so it is always advised to take local law advice for the place a Guarantor is incorporated, even if the guarantee itself is under English law, as this could restrict enforceability. For example, some jurisdictions may require a guarantee to be registered, taxed, executed in a specific way, or include specific wording. 

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